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‘Impact Alphas’ Stake Their Claim

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Word on the Street: When pitching the big-money players, don’t lead with “impact.” Try “alpha” instead.

That was the message from pension-fund advisors to leaders of the impact investing community who were gathered in San Francisco for the annual SOCAP conference.

“If  you want a check, say, ‘We’re going to make you more money than TPG (Texas Pacific Group), Blackstone or Morgan Stanley,” advised Allan Emkin, managing director of Pension Consulting Alliance, who advises pension plans such as CalSTRS, CalPERS, the Minnesota State Investment Board and the Virginia Retirement System. “Say you have better access to markets, or can better access government subsidies, or better understand technology. You need a competitive advantage. You’re not going to get a check just because you have a values-system.”

Emkin was speaking inside the San Francisco Federal Reserve building, at “Capital Markets for Impact at Scale,” a select convening underwritten by the Rockefeller Foundation. The event coincided with SOCAP12, held across town at an old Army base on San Francisco Bay. But the discussion behind the Fed’s barricaded perimeter and armed guards had a far different vibe than the mosh-pit atmosphere of SOCAP (accentuated by the America’s Cup catamarans slicing past the waterfront and the roar overhead of the Navy’s Blue Angels, in town for Fleet Week).

Two clans circled warily at the Fed convening and through the rest of SOCAP week. The “impact-first” crowd dominates SOCAP, celebrating social entrepreneurs and distributed innovation and nibbling only at the margins of the global capital markets. The focus is on smaller funds in the $10 million to $50 million range, including nonprofit pioneers such as Acumen Fund. With roots in philanthropy and “program-related investments” that, per tax law, cannot expect market-rate returns, a large faction of the social-capital crowd embraces below-market returns as a duty — a marker they’re attacking truly tough challenges of poverty, exclusion and system-change.

That framing is unlikely to fly with the institutional stewards of billions of dollars in retirement and customer assets, who feel duty-bound to maximize returns and are looking for opportunities more in the $100 million to $500 million range.

Still, representatives of Morgan Stanley, Goldman Sachs, Credit Suisse, Bank of America and other asset managers watched with keen interest the passion at SOCAP around impact and sustainability — catnip to the UHNW (ultra-high net worth) customers banks covet — and scouted opportunities for above-market returns. (For an excellent primer on the impact opportunity — and obstacles — for the $20 trillion institutional capital market, see the  “Impact at Scale” report from InSight, the research arm of Pacific Community Ventures, which co-hosted last week’s event.)

At the intersection are a growing number of fund managers who are working hard to illuminate large-scale investment opportunities with positive environmental and social impact. “Finance-first” doesn’t really describe them, since they’re doing much more than sprinkling impact dust over conventional investing. Better to call them “impact alphas,” investors and fund managers who are leveraging social and environmental trends to unlock hidden value and generate above-market returns.

One of the most outspoken proponents of the impact alpha opportunity is David Chen, managing partner of Equilibrium Capital in Portland and who, as one of the curators of the Rockefeller event at the Fed, served as kind of a bridge between the two worlds. Chen is a collector of examples in which “sustainability” itself drives long-term, market-beating returns by reducing input costs, raising productivity, mitigating risk, enhancing asset values — and capturing growth opportunities.

“This is all driven by four billion people wanting to eat chicken and drive a car,” Chen told the gathering. An emerging global middle class is changing its diet, its family structure, and its quality of life, with huge implications for both risk management on the downside and asset strategy on the upside. “We are moving into the Maslow Hierarchy of Needs stage – food, water, shelter, clothing and the redefinition of what it means to the providing of those resources to the four billion. It’s a fundamental dislocation.”

What’s more, steady returns of 5 to 6 percent over 15 or 20 years can trump volatile results, even if they may be higher in the short-term, Chen said.

As if on cue, on the eve of the gathering, the $7 billion Michigan Municipal Employees’ Retirement System allocated $180 million to the Australian Pastoral Fund, which has been buying up large tracts of grassland and cattle operations in northern and eastern Australia. Equilibrium Capital, a holding company, has a stake in Australian Pastoral Funds Management, which manages the fund.

Healthy grasslands and happy cows were less of a consideration for the pension fund than growing demand for meat from Asia’s rising middle class. According to Pensions and Investments, Jeb Burns, MERS’ chief investment officer hopes “to generate uncorrelated returns by capitalizing on global natural resource-based macro trends.” (For more on impact investing and uncorrelated returns, see “Hedging with Impact Investments?”)

At Equilibrium Capital’s conference this summer, Alan Hayes, the manager of Australian Pastoral Funds, laid out Australia’s competitive advantages of wide open space, low population density and livestock culture. “All the profitability is in grass fed animals,” he said, and controlling vast swaths of grasslands makes it possible to intelligently move cattle around. The feed grows itself.

“Profitability is underpinned by sustainability,” Hayes said. “If you look after your land, it will look after you. If you look after livestock, they’ll look after you as well. A happy cow gets pregnant and a happy steer gets fat and that’s where our money comes from.”

Bring it on, was Emkin’s essential message. His clients are already investing in clean tech, low-income housing, energy retrofits and such assets as water districts, sewage treatment and air scrubbers — but always based first on financial benefits. He sees huge potential in water storage, food production and energy transmission. “There’s unlimited capital if it’s structured right,” he said.

A number of large real estate funds have adopted impact themes while targeting above-market returns, including JP Morgan’s Urban Renaissance Property Fund, which targets affordable and workforce housing; Gerding Edlen’s green development funds; and Jonathan Rose Cos.’ which greens existing mixed-use projects to reduce costs and boost values.

From the other side, a growing number of impact fund managers are trying to deliver competitive returns with funds targeted at carbon markets, sustainable forestry, food production, financial services, low-income housing and other opportunities. Some onetime “impact first” managers are moving upmarket on their second or third funds, and with valuable experience under their belts are targeting market-rate (or market-beating) returns.

Other trends are driving a convergence as well, as a younger generation take over family offices and foundations from their parents and grandparents, and as local and national governments seed impact funds to catalyze private capital for public benefit. Financial innovations in the non-profit or below-market sector erve as R&D for instruments and vehicles that, properly tweaked, can go mainstream.

The new impact alpha investing will look and feel very different from seed- and early-stage venture capital-style investments in innovations for the bottom of the economic pyramid that have been the staple of SOCAP and the two clans of impact investing may segment themselves as the market grows. But even at SOCAP, discussion was turning toward solutions to complex problems, which will need a range of types of capital, including debt, structured finance and investments in real assets like agricultural and timber lands, water resources and sanitation systems.

“Somebody has to be in the vanguard – you are in the vanguard,” Emkin said. “At some point you will become mainstream.”

In the meantime, language matters. If “impact” starts to invoke “alpha,” it could be a very disruptive trend indeed. If “impact” is taken to mean “haircut,” the managers of trillions of dollars in assets will find their own way to the same mega-trends.

“If you walk in the door with the wrong label, you’re not going to be put in the right pile. You’re going to gather dust, or be shredded,” Emkin said. “You have to be in the pile that makes money.”

About the author: David Bank

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